Jo is a 34-year-old management consultant earning pounds 40,000 a year. She has recently inherited pounds 100,000 and is concerned to invest it for growth. She has very little pension provision as her company is small and does not provide a pension. Jo's main concerns are providing further education, possibly at university, for Tom, her two-year-old son. She sees the pounds 100,000 as a long-term investment.
Her husband, David, is 32 and was until recently a freelance journalist earning pounds 20,000 per annum. He is now taking a career break to study for a philosophy degree and secondly to spend more time with Tom. David has a PHI policy that he took out five years ago when freelance. His earnings are now reduced to about pounds 3,000 to pounds 4,000 per annum. Should he reduce his PHI cover? A concern of his is that he was diagnosed diabetic three years ago. He feels he should increase his life assurance but is not sure how he would be viewed.
Jo will have many calls on the pounds 100,000 she has inherited. She can make up for lost time with her pension by investing a lump sum to recoup her past allowances and indeed the tax relief. She can go back over seven tax years and since she is a higher rate taxpayer may get 40 per cent relief on contributions.
I would recommend that pounds 30,000 is set aside for pension provision. This will mean that pounds 50,000 is invested, assuming that higher rate tax relief can be obtained on the full lump sum. This in turn will produce an income in real terms of pounds 9,000 for Jo at age 60. If she also invests pounds 240 per month net and increases this as her income increases, then she can look forward to an income of pounds 21,000 in real terms at age 60.
Choosing a self-invested pension means that she will get tax relief in the normal way, but she can diversify her investments within the pension plan into shares, property or unit and investment trusts. If she has other pensions, then she may transfer these into a self-invested option including any amounts left in previous company schemes.
As far as Tom's education is concerned, we have 16 years until the money is required. In order to provide the equivalent of pounds 4,000 per annum for say three years while Tom is in higher education, Jo will need to set aside around pounds 8,000. This money should be essentially put into reasonably secure long-term investments such as blue chip stock and diversified international funds.
It may also be sensible nearer the time that Tom will need the money to move the money away from equities to more secure forms of investment such as building societies and National Savings products.
Jo and David should ensure that at least pounds 10,000 is kept in a building society for short-term needs. This should be in David's name as he is a lower tax payer and therefore there will be no extra tax to pay on the interest. There are no tax implications for Jo passing the money to David as they are married.
The remainder of the money can be invested in a more relaxed fashion. Jo should ensure that any costly borrowings, such as credit cards and bank loans, are fully repaid. She should also look at repaying part of her mortgage if she has one, even though interest rates are low at the moment. Certainly she should look to use up her TESSA allowance and put some money in National Savings Certificates. I like the index-linked ones giving 2.5 per cent guaranteed above the rate of inflation for a five- year period and a tax-free return at the end of it.
The rest should be invested in equities. The spread that I would recommend is 40 per cent in the UK, the rest spread internationally, and I think it is much more sensible for her to invest in unit and investment trusts than direct in shares.
David's concerns are about his health insurance and life assurance. He should firstly check his PHI policy to ensure that he is in the correct class of occupation, to ensure that he is not paying too much for his policy. If he works from home his risks are no higher than, say, a bank manager.
On a broader matter, if he were to claim on his PHI policy, he would not be able to reap the full benefits because his income has reduced. However, bearing in mind that he is diabetic and that this was diagnosed since the policy start date, my advice to him would be to keep the policy as it is, because if he reduces his benefits, when he comes to resume work full time in the future, he will have to apply for increased benefits. There will usually be fresh underwriting at that stage and the insurance companies would take a view on his diabetes which will mean that he will pay higher premiums, if indeed he could get insurance at all.
Life assurance companies vary quite dramatically in the way that they view a diabetic or indeed anyone else with a medical condition. David's best option is to apply to three or four insurance companies in order to see which company will come up with the best premium for him.
By taking a career break, David's pension arrangements will also be affected. As such, if he has not made up his full allowances in the past, Jo could use some of her lump sum to fund for David's pension.
If Jo has not got a health insurance policy, she should also consider this seriously. As David has discovered, health insurance is best taken out whilst you are healthy rather than waiting until it is too late. Her pounds 100,000 is earmarked for education and retirement planning. As the main breadwinner, at least for the next three to four years, she needs to ensure that if she dies, there is enough money so that David can finish his degree and that all other commitments can be maintained.
Jo and David should consider Critical Illness policies, particularly to cover any indebtedness such as a mortgage. These policies will provide a lump sum in the event of diagnosis of specific illnesses. Once again David needs to be careful and to shop around in view of his medical condition.
Amanda Davidson is a partner at Holden Meehan, independent financial advisors. Telephone: 0171-404 6442. Amanda recently won the Planned Savings Stock Market Investment award as part of the IFA of the Year Awards.